The finance crises that culminate with the Greece situation shows that majority of European countries are facing balance-of-payments difficulties and it is clear that actual mechanism couldn't face the situation. This paper wants to highlight some of the proposals related to the development mechanisms, such the creation of the European Monetary Fund or the design of the "European Mechanism for Financial Stability" (EMFS), which could include the EMF, showing also the actual mechanism of financing through International Monetary Fund (IMF).Some pro and counter arguments are furthermore taken into discussion.European Monetary Fund - EMF, International Monetary Fund - IMF, European Union - EU, sovereign defaults, financing mechanism, financial system

Firtescu Bogdan

English

Research Papers in Economics

  736
EUROPEAN MONETARY FUND - BETWEEN ILLUSION AND FUTURE 
INSTRUMENT FOR EUROPEAN FINANCIAL STABILITY   
Fîr￿escu Bogdan  
Universitatea ”Alexandru Ioan Cuza” 
Facultatea de Economie ￿i Administrarea Afacerilor 
 
The finance crises that culminate with the Greece situation shows that majority of European 
countries  are  facing  balance-of-payments  difficulties  and  it  is  clear  that  actual  mechanism 
couldn’t face the situation. This paper wants to highlight some of the proposals related to the 
development mechanisms, such the creation of the European Monetary Fund or the design of the 
“European Mechanism for Financial Stability” (EMFS), which could include the EMF, showing 
also the actual mechanism of financing through International Monetary Fund (IMF).Some pro 
and counter arguments are furthermore taken into discussion.  
 
Keywords: European Monetary Fund - EMF, International Monetary Fund – IMF, European 
Union – EU, sovereign defaults, financing mechanism, financial system.  
 
Cod JEL: F36. 
 
Actual stage of financial crises – foundation and argument for construction of the European 
Monetary Fund (EMF) 
It is considered that actual financial crises have entered in a second phase, regarding the 
public debt crises, facing the threat of sovereign default. The case of Greece is frequently 
taken into discussion, but other countries are also confronting with large public debts. As 
Eurostat shows in its latest statistics
476, in 2009, the government deficit and government debt of 
both the euro area (EA16) and the EU27 increased compared with 2008, while GDP fell. In the 
euro area the government deficit to GDP ratio increased from 2.0% in 20083 to 6.3% in 2009, 
and in the EU27 from 2.3% to 6.8%. In the euro area the government debt to GDP ratio increased 
from 69.4% at the end of 2008 to 78.7% at the end of 2009, and in the EU27 from 61.6% to 
73.6%.  
In 2009 the largest government deficits in percentage of GDP were recorded as follows: Ireland 
(-14.3%),  Greece  (-13.6%)  the  United  Kingdom  (-11.5%),  Spain (-11.2%),  Portugal  (-9.4%), 
Latvia (-9.0%), Lithuania (-8.9%), Romania (-8.3%), France (-7.5%) and Poland (-7.1%). No 
Member State registered a government surplus in 2009. The lowest deficits were recorded in 
Sweden (-0.5%), Luxembourg (-0.7%) and Estonia (-1.7%). The data suggests a worsening in 
government balance relative to GDP in 2009 compared with 2008 in twenty-five states, and only 
in two (Estonia and Malta) an improvement. 
At the end of 2009, the lowest ratios of government debt to GDP were recorded in Estonia 
(7.2%), Luxembourg (14.5%), Bulgaria (14.8%), Romania (23.7%), Lithuania (29.3%) and the 
Czech Republic (35.4%). Twelve Member States had government debt ratios higher than 60% of 
GDP in 2009: Italy (115.8%), Greece (115.1%), Belgium (96.7%), Hungary (78.3%), France 
(77.6%), Portugal (76.8%), Germany (73.2%), Malta (69.1%), the United Kingdom (68.1%), 
Austria (66.5%), Ireland (64.0%) and the Netherlands (60.9%). 
The  economic  and  financial  evolution  in  EU16  and  EU27  related  to  government  activity 
evaluated in percentage of GDP for the last 4 years can be summarized in the table below (see 
Table 1): 
 
                                                       
476 http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-22042010-BP/EN/2-22042010-BP-EN.PDF, 
p.1-2, accessed on 23
rd of April, 2010.   737 
Table 1 – Government deficits (percentage of GDP) in 2006-2009 
 
  2006  2007  2008  2009 
Euro area (EA16)         
Government expenditure  46.7  46.0  46.8  50.7 
Government revenue  45.3  45.4  44.9  44.4 
Government debt  68.3  66.0  69.4  78.7 
EU27         
Government expenditure  46.3  45.7  46.9  50.7 
Government revenue  44.9  44.9  44.6  44.0 
Government debt  61.4  58.8  61.6  73.6 
Source:  Eurostat,  http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-22042010-BP/EN/2-
22042010-BP-EN.PDF  
 
Euro area annual inflation was 1.4% in March 2010, up from 0.9% in February, compared with 
the value recorded a year earlier the rate - 0.6%. The lowest 12-month averages up to March 
2010 were registered in Ireland (-2.3%), Portugal (-0.8%) and Estonia (-0.7%), and the highest in 
Romania  (5.0%),  Hungary  (4.8%)  and  Poland  (3.9%)
477.As  shown  above,  macroeconomic 
indicators worsened in the last 2 years, suggesting the profound implication of financial crises in 
majority of the European States. These data indicates that actual European Union economic and 
financial mechanisms are still inadequate to face financial crises. As some authors suggested
478, 
related  to  monetary  policy  of  European  Central  Bank,  an  imperfect  functioning  may  cause 
disproportionate  inflation,  while  wrong  fiscal  policy  decisions,  such  the  excessive  deficit 
procedure may induce a threat of sovereign default. It appears that Greece is the weakest, given 
its high public debt (about 120% of GDP) compounded by a government budget deficit of almost 
13% of GDP, a massive external deficit of 11% of GDP, and the loss of credibility from its 
repeated cheating on budget reports. 
 
Solutions for debt crisis and strengthening economic policy coordination in the Euro-zone 
In actual case, it is suggested that given the intense pressure from financial markets, is likely that 
a tough fiscal adjustment agenda (or rather the promise that one will be forthcoming) might not 
be enough to avoid a ‘sudden stop’ of necessary external funding of the public sector. When this 
happens the EU will no longer be able to fudge the question of whether (and in what form) it can 
provide public financial support to one of its members
479. 
Some opinions propose that the crisis in Greece calls for standard remedies and the solution 
would be to bring in the IMF. A stand-by agreement involving conditional lending would provide 
financial assistance and fiscal adjustment measures which should restore confidence. However, 
Euro-zone and EU authorities appear to be against this
480.  
Another proposal came from The European Commission that appear to support the creating a 
European  Monetary  Fund  (EMF)  to  help  Euro-zone  countries  facing  balance-of-payments 
difficulties.  Officials  of  the  EU  agreed  that  “The  Commission  is  ready  to  propose  such  a 
                                                       
477 http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-16042010-BP/EN/2-16042010-BP-EN.PDF. p. 
1, accessed on 23
rd of April, 2010. 
478 see Varela D. – Guvernarea Uniunii Europene, Institutul European, Ia￿i, 2008, p. 128. 
479 Gros D., Mayer T. - Towards a Euro(pean) Monetary Fund, http://www.dbresearch.com/ PROD 
/DBR_INTERNET_EN-PROD/PROD0000000000253712.pdf , p. 1. 
480 see Pisani-Ferry J., Sapir - The best course for Greece is to call in the Fund, 2010, 
http://www.ft.com/cms/s/0/01554c86-0f69-11df-a450-00144feabdc0.html   738
European instrument for assistance, which would require the support of all euro area member 
states”
481. Germany's finance minister, said in an interview that he would present proposals for a 
European monetary fund soon. He said that the Euro-zone needed an institution “for its internal 
stability”. This new body would not compete with the International Monetary Fund, he said, but 
would benefit from the IMF's experience and have comparable powers to the fund, he said. He 
said that accepting financial assistance from the IMF would be an admission that the Euro-zone 
countries were unable to solve their problems by themselves
482.  
An  additional  proposal  came  from  the  PES,  together  with  the  S&D  Group  at  the  European 
Parliament (on 2
nd of March, 2010), suggesting a plan that implies a three step strategy to address 
the sovereign debt crisis and to strengthen economic policy coordination in the Euro-zone: 
1. the Greek sovereign debt crisis must be solved without delay – it is necessary to establish an 
emergency credit facility mechanism at the European level, allowing Greece to re-finance its 
economy at a fair price;  
2. the emergency mechanism must be converted, over the medium-term, into a permanent feature 
of the Euro-zone – creation of a crisis-management mechanism, the “European Mechanism for 
Financial Stability” (EMFS); 
3.the  development  of  further  EMFS  into  a  long-term  framework  for  strengthened  economic 
governance in the Euro-zone
483. 
As seen before, there are three possible mechanism: 
- International Monetary Fund (IMF) assistance 
- creation of the “European Monetary Fund” (EMF) 
- design of the “European Mechanism for Financial Stability”, that could include the EMF (not 
discussed in this paper below).  
The financing through IMF and characteristics of the “European Monetary Fund” (EMF) are 
discussed below.  
 
Financing Mechanism through IMF lending 
Upon request by a member country, an IMF loan is usually provided under an "arrangement," 
which may, when appropriate, stipulate specific policies and measures a country has agreed to 
implement to resolve its balance of payments problem. The economic program underlying an 
arrangement is formulated by the country in consultation with the IMF and is presented to the 
Fund's Executive Board in a "Letter of Intent." Once an arrangement is approved by the Board, 
the loan is usually released in phased installments as the program is implemented
484. 
 
IMF Facilities 
Over the years, the IMF has developed various loan instruments, or "facilities," that are tailored 
to address the specific circumstances of its diverse membership
485. Low-income countries may 
borrow on concessional terms through the Extended Credit Facility (ECF), the Standby Credit 
Facility (SCF) and the Rapid Credit Facility (RCF). Non-concessional loans are provided mainly 
through Stand-By Arrangements (SBA), the Flexible Credit Line (FCL), and the Extended Fund 
Facility (which is useful primarily for longer-term needs). The IMF also provides emergency 
assistance to support recovery from natural disasters and conflicts. All non-concessional facilities 
                                                       
481 Brunsden, J., Taylor, S. - Commission backs European Monetary Fund, 2010 
http://www.europeanvoice.com/article/2010/03/commission-backs-european-monetary-fund-/67349.aspx  
482 ibid. 
483 see http://www.pes.org/en/system/files/ Adopted_PES_European_Mechanism_for_Financial_ Stability 
250310_EN.pdf 
484 see*** - IMF Lending, IMF Factsheet, p.1- 4,  http://www.imf.org/external/np/exr/facts/howlend.htm.  
485 for information related to IMF financing see Voinea, Gh. – Mecanisme ￿i tehnici valutare 
interna￿ionale, Editura Sedcom Libris, Ia￿i, 2004, p. 239-250   739 
are subject to the IMF's market-related interest rate, known as the "rate of charge," and large 
loans (above certain limits) carry a surcharge. The IMF facilities can be grouped as shown in 
Figure1. 
Figure 1 – IMF Facilities 
 
The new concessional facilities for LICs were established in January 2010 under the Poverty 
Reduction and Growth Trust (PRGT) as part of a broader reform to make the Fund's financial 
support more flexible and better tailored to the diverse needs of LICs. Access limits and norms 
have been approximately doubled compared to pre-crisis levels. Financing terms have been made 
more  concessional,  and  the  interest  rate  is  reviewed  every  two  years.  All  facilities  support 
country-owned programs aimed at achieving a sustainable macroeconomic position consistent 
with strong and durable poverty reduction and growth. Most important instruments are presented 
below. 
The Extended Credit Facility (ECF) succeeds the Poverty Reduction and Growth Facility (PRGF) 
as the Fund's main tool for providing medium-term support to LICs with protracted balance of 
payments problems. Financing under the ECF currently carries a zero interest rate, with a grace 
period of 5 ½ years, and a final maturity of 10 years. 
The Standby Credit Facility (SCF) provides financial assistance to LICs with short-term balance 
of payments needs. The SCF replaces the High-Access Component of the Exogenous Shocks 
Facility (ESF), and can be used in a wide range of circumstances, including on a precautionary 
basis. Financing under the SCF currently carries a zero interest rate, with a grace period of 4 
years, and a final maturity of 8 years. 
The Rapid Credit Facility (RCF) provides rapid financial assistance with limited conditionality to 
LICs facing an urgent balance of payments need. The RCF streamlines the Fund's emergency 
assistance for LICs, and can be used flexibly in a wide range of circumstances. Financing under 
the RCF currently carries a zero interest rate, has a grace period of 5% years, and a final maturity 
of 10 years. 
Stand-By Arrangements (SBA). The bulk of Fund assistance to middle-income countries is 
provided through SBAs. The SBA is designed to help countries address short-term balance of 
payments  problems.  Program  targets  are  designed  to  address  these  problems  and  Fund 
disbursements are made conditional on achieving these targets ('conditionality'). The length of a 
SBA is typically 12-24 months, and repayment is due within 3%-5 years of disbursement. SBAs 
may be provided on a precautionary basis—where countries choose not to draw upon approved 
amounts but retain the option to do so if conditions deteriorate— both within the normal access   740
limits  and  in  cases  of  exceptional  access.  The  SBA  provides  for  flexibility  with  respect  to 
phasing, with front-loaded access where appropriate. 
Flexible Credit Line (FCL). The FCL is for countries with very strong fundamentals, policies, 
and  track  records  of  policy  implementation  and  is  particularly  useful  for  crisis  prevention 
purposes. FCL arrangements are approved for countries meeting pre-set qualification criteria. 
The length of the FCL is 6 months or 1 year (with a mid-term review) and the repayment period 
the same as for the SBA.  
 
Financing Mechanism through EMF 
The mechanism should refer to an implementation in 2 stages. During Stage I: any member 
country  could  call  on  the  funds  of  the  EMF  up  to  the  amount  it  has  deposited  in  the  past 
(including interest). The government of the country in question could thus issue public debt with 
a guarantee of the EMF up to this amount.  
In Stage II any drawing on the guarantee of the EMF above this amount would be possible only if 
the country agrees to a tailor-made adjustment plan supervised jointly by the Commission and the 
Eurogroup. 
This proposed mechanism
486 intends to limit the moral hazard
487 problem, because only countries 
that breach the Maastricht criteria have to contribute. The authors propose that contribution rates 
would be calculated on the following bases: 
- 1% annually of the stock of ‘excess debt’, which is defined as the difference between the actual 
level of public debt (at the end of the previous year) and the Maastricht limit of 60% of GDP. For 
Greece with a debt-to-GDP ratio of 115%, this would imply a contribution to the EMF equal to 
0.55%. 
- 1% of the excessive deficit, i.e. the amount of the deficit for a given year that exceeds the 
Maastricht limit of 3% of GDP. 
Countries with exceptionally strong public finances would not need to contribute because they 
would carry the burden. Their backing of the EMF (and the high rating of their bonds in the 
portfolio of the EMF) would be crucial if the EMF were called into action. 
Authors argued that taxing countries under fiscal stress to fund the EMF would only aggravate 
their problems and  most of the contributions would materialize a long time before solvency 
problems become acute.  
An illustrative calculation estimates that the suggested funding mechanism, the EMF would have 
been able to accumulate 120 billion euro in reserves since the start of EMU – enough probably to 
finance the rescue of any of the small-to-medium-sized euro area member states
488. 
There are some issues to be discussed related to this proposal. A pro argument for the EMF is one 
suggested  by  the  authors  themselves  -  the  EMF  could  provide  for  an  orderly  sovereign 
bankruptcy procedure that minimizes the disruption resulting from a default. Some specialists 
suggested  that  such  mechanism  is  only  a  redistribution of funds  from  a  group  of  prudential 
country to non-prudential one. There is also a technical issue – the Treaties do not agree such an 
institution. Such mechanism has also to have consistency and interdependency with other related 
elements, as being part of financial system
489. Finally, "EMF per se is not a solution for another 
crisis  but  could  be  part  of  a  prevention  mechanism,  if  it  implements  adequate  support  for 
                                                       
486 according to Gros D., Mayer T. – op.cit., p.5 
487 see also Gros D., Mayer T. – How to Deal with the Threat of Sovereign Default in Europe: 
Towards a Euro(pean) Monetary Fund, 2010, http://www.ceps.eu/system/files/article/2010/04/064-095-
Forum.pdf 
488 according to Gros D., Mayer T. – op.cit., p. 6 
489 see Fîr￿escu, B. – Sistemul financiar al României, Editura Universit￿￿ii ”Al. I. Cuza”, Ia￿i, 2010   741 
reformed policies by Member States intending to tackle the structural root of the crisis"
490.It is 
hard to pronounce that the EMF would be implemented in reality, because despite pro and cons, 
the creation of the EMF remain, in final, a political decision. 
 
Bibliography 
 
1. Brunsden, J., Taylor, S. - Commission backs European Monetary Fund, 2010 
http://www.europeanvoice.com/article/2010/03/commission-backs-european-monetary-fund-
/67349.aspx 
2.Fîr￿escu, B. – Sistemul financiar al României, Editura Universit￿￿ii ”Al. I. Cuza”, Ia￿i, 2010 
3.Gros  D.,  Mayer  T.  -  Towards  a  Euro(pean)  Monetary  Fund,  http://www.dbresearch.com/ 
PROD /DBR_INTERNET_EN-PROD/PROD0000000000253712.pdf 
4. also Gros D., Mayer T. – How to Deal with the Threat of Sovereign Default in Europe: 
Towards  a  Euro(pean)  Monetary  Fund,  2010,  http://www.ceps.eu/  system/files/article 
/2010/04/064-095-Forum.pdf 
5.  Pisani-Ferry  J.,  Sapir  -  The  best  course  for  Greece  is  to  call  in  the  Fund,  2010, 
http://www.ft.com/cms/s/0/01554c86-0f69-11df-a450-00144feabdc0.html 
6. Varela D. – Guvernarea Uniunii Europene, Institutul European, Ia￿i, 2008 
7. Voinea, Gh. – Mecanisme ￿i tehnici valutare interna￿ionale, Editura Sedcom Libris, Ia￿i, 2004 
 
 
 
   
                                                       
490 Canfin P., cited from article A European Fund to bail out countries?, 23r of March 2010, 
http://www.europarl.europa.eu/news/public/story_page/042-71017-081-03-13-907-20100319STO70945-
2010-22-03-2010/default_en.htm 

EUROPEAN MONETARY FUND - BETWEEN ILLUSION AND FUTURE INSTRUMENT FOR EUROPEAN FINANCIAL STABILITY

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EUROPEAN MONETARY FUND - BETWEEN ILLUSION AND FUTURE INSTRUMENT FOR EUROPEAN FINANCIAL STABILITY

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